Basics of Cost and Costing in Management Accounting
Cost is a word used to describe the money spent on a particular thing. In our private lives, we talk about the cost of running a car or heating our home.
In management accounting, the cost can be viewed as expenses incurred in the process of production or services of a business. In a business context, we can talk about the cost of labour, the cost of running a department, or the cost of a particular product or service sold to customers.
The cost of a good is considered to be its purchase price. The cost of a service is its fee. It is defined as the economic burden to an enterprise of production or service. It may be internal or external. The costs of management are internal costs.
Each corporation incurs costs – regardless of whether we are self-employed, work for local government, or work for a profit-seeking organisation. Costs are incurred when an organisation consumes resources to accomplish its business aim of customer satisfaction. Materials, human work, purchased services, equipment wear and tear, and even money itself, which has an interest cost, are used.
Accountants refer to these ongoing or operational expenditures as revenue to differentiate them from the initial cost of new physical assets like buildings, equipment, and vehicles. Capital expenditure refers to the expenditures associated with the acquisition of these fixed assets. This article focuses on the former, i.e. revenue spent on the organization’s day-to-day operating expenditures associated with performing work for its customers and clients.
What is Costing?
Costing is the process of analysing expenses in order to assign them to specific products/services, activities, departments, and time periods. This objective cost analysis is exemplified when costs are allocated to the final product or department that consumes them. Additionally, subjective cost analysis is required. This section examines the nature and types of expenses and explains them in various ways – for which we will need to pick up some jargon later.
Costing is a systematic process that enables an organisation to track and control costs. In other words, it enables the organisation to collect, analyse, and report costs. By doing so, the organisation can better understand where and when its costs are being spent and ultimately plan, develop, and implement initiatives that improve efficiency and productivity. The process of calculating costs is vital for achieving profitable operations in any organisation. Costing can also be used to achieve more cost-efficient and sustainable business models.
Costing is, therefore, an in-house accountancy service to provide relevant information to managers in a timely and cost-effective way. We shall start our study of costing by considering where cost information comes from and how accountants deal with it.
What Type of Information Does a Costing System Provide?
A costing system provides a comprehensive overview of the costs associated with producing goods or services. It gathers, categorizes, and analyzes cost data to provide valuable insights for decision-making, cost control, and profitability analysis. Here are some of the key types of information that a costing system provides:
Cost of Goods Sold (COGS): COGS is a critical metric for determining the profitability of a business. It represents the direct costs incurred in producing the goods or services sold during a period. A costing system provides detailed information on the various elements that contribute to COGS, such as direct materials, direct labour, and manufacturing overhead.
Product or Service-Level Costing: A costing system can break down the costs of producing individual products or services. This allows businesses to identify the most profitable products or services and make informed decisions about pricing, production, and product mix.
Cost Behavior Analysis: A costing system can help to understand how costs change in relation to changes in production volume or activity levels. This analysis is crucial for budgeting, planning, and making decisions about resource allocation and cost control strategies.
Standard Costing and Variance Analysis: Standard costing involves setting predetermined cost standards for various activities or processes. A costing system can compare actual costs to these standards, identifying variances that indicate areas for potential cost savings or efficiency improvements.
Inventory Valuation: A costing system is essential for valuing inventory accurately. It provides a method for assigning costs to raw materials, work-in-progress, and finished goods, ensuring that the balance sheet reflects the true value of inventory.
Cost Allocation and Transfer Pricing: In a multi-department or multi-location organization, a costing system can help allocate costs appropriately among different departments or divisions. This is particularly important for transfer pricing, where goods or services are transferred between departments or subsidiaries at a predetermined price.
Performance Benchmarking and Cost Comparisons: A costing system allows businesses to benchmark their costs against industry standards or internal targets. This benchmarking can identify areas where costs are higher than expected and provide insights for improvement.
The above examples of the type of information are not mutually exclusive. There can be several other types of information businesses can use from the costing system based on the nature of their business and industry requirements.
Conclusion
Cost in management accounting is defined as the expenditure incurred by a firm while running a business. It is the sum of all expenses, including salaries, rent and supplies, as well as the depreciation of fixed assets. Therefore, we can say that management accounting costs are the sum of all expenses incurred by a firm in running a business. Therefore, the cost in management accounting is also called total cost accounting.